When cash flows are stated in real dollars and discounted using the a nominal rate,

Question

Quizplus · Accepted Answer

Stating cash flows in real dollars adjusts for inflation, but discounting those cash flows using a nominal rate incorporates the effects of inflation twice, resulting in an understatement of the Present Value. This is because the nominal rate already includes an inflation component, which means it is higher than the real rate. Therefore, discounting using a nominal rate results in a lower Present Value than discounting using a real rate, and hence understates the value of the future cash flows.

When Cash Flows Are Stated in Real Dollars and Discounted